Talking Points – May 2021

This past week’s Barron’s cover story was all about inflation. It has been the most discussed topic in many recent client meetings and is connected with many aspects of our lives right now. We have discussed inflation a couple of times earlier this year and our views have remained mostly the same, but with so much attention on the topic it is time for a deeper look.

Based on the most recent Consumer Price Index (CPI) inflation is running at its highest level since 2008.

If you happen to be one of the many doing home renovations, you are well aware of the price increases in lumber. This amazing chart shows that $50,000 worth of lumber in May 2020 could be used to build just over 10 homes. Now it can only be stretched to little more than two homes.

However, as we dig deeper into the data it seems much of what is driving the broader inflation higher is from a very positive event. The reopening of the U.S. economy and people’s desire to get back to a more normal life post vaccine has dramatically increased the prices of airfare, hotels and rental cars. The chart below shows the difference in inflation data of some of those categories compared to all else is significant.

Source: @pearkes

From an investment standpoint it is important to know how inflation has affected stocks historically. Typically, a modest amount of inflation in the 2-4% range is considered good for stocks as most strong companies can pass along those increased expenses and many consumers income goes up enough to offset. The real issue arises when inflation spikes like it did in the 1970’s and contributed to a weaker than normal stock market during that period.

Source: The Irrelevant Investor

It is always very difficult to know what any one factor means for financial markets. It is true that generally markets like modest inflation, but a seemingly ideal level of inflation in the 2000’s resulted in a negative stock return. The reality is there is at any time many factors driving stocks in both directions that it is almost impossible to pinpoint the effect of each.

The Federal Reserve has thus far been adamant they view inflation risks as transitory and not enough for them to raise rates, or even slow their bond purchases. They are likely commenting solely on the supply bottlenecks in areas such as semiconductors for cars and appliances that have boosted prices and other Covid related disruptions that will work themselves out in the months ahead and keep price increases in check. That seems like a fairly good possibility. What is much less clear is what the longer-term inflation consequences could be from the large increased government debt load, as well as the sizable fiscal and monetary stimulus.

With everyone concerned about inflation the contrarian in us feels perhaps the concerns have gone too far. Essentially the opposite of when so many investors became enamored by the significantly overvalued “story stocks” earlier this year before they came crashing down. We also recall how there have been many wrongly anticipating runaway inflation since the Fed’s quantitative easing began in 2008. Only this time it admittedly feels more real as we see it all around us.

If inflation does become a longer-term story and the correlated interest rates also increase it will be important to be aware of the implications on financial assets. We have made a number of modest shifts over the past six to nine months as it seems the areas that have been the strongest the past 10 years could very well be different the next 10.

May 12, 2021 – A Cycle Can Last Many Years

With the short-term focus of investors these days it can be too easy to forget how long some cycles can last.

The commodity index is perhaps the greatest example of how long cycles can go on. Historically it has traded in a sideways pattern for 10-20 years before finally breaking higher for a decade of increasing prices.

Source: Strategas Research

Over the past year commodities have had a massive surge, but so have most assets. Will commodities remain in their sideways pattern, or breakout to a new cycle uptrend that could last for many years? How this question is ultimately answered could have massive implications across financial markets and the broader economy for years to come. Investors should remain open minded and aware of how this cycle develops.

May 5, 2021 – Bull Vs. Bear Markets 

Occasionally it is useful to take a very long-term look at stock market history to appreciate both the power of stock market growth over time and how long a typical bull market lasts versus a typical bear market. 

The chart below dates back to the 1960’s with a dark line representing the S&P 500 and moving strongly from the bottom left to the upper right. Most people are aware of that general tendency, but it is still impressive to see. What many investors are less familiar with is that the average bull market has lasted nearly 6 years and increased more than 200%. Comparatively the average bear market has lasted just over a year with a decline of 38%. 

Source: Charles Schwab & Co

Last year’s pandemic influenced bear market was abnormal in length at just one month. However, the decline of 34% was nearly in line with history. With stocks enormous run since the March 2020 lows, it can leave some investors wondering how much higher this market can go. Of course, no one knows that answer for sure, but history would indicate there could be a fair amount of higher prices before the next bear market eventually arrives. That does not mean there won’t be bumps along the way. Corrections of 5-15% are not unusual and should be expected even during bull markets. By focusing on the big picture and less on the short-term noise investors are likely to enjoy less stress and be better equipped to remain engaged with their long-term plan. 

Source: Greg Towner, CFA, CMT